Wednesday, 26 November 2014

Big defaulters watch out: RBI guv Rajan has begun the clean up drive

Reserve Bank of India (RBI) governor Raghuram Rajan has made it abundantly clear that he won't tolerate the idea of regulatory forbearance (the practice of companies seeking postponing of recognition of bad loans) any more.

“Forbearance is ostrich-like behaviour, hoping the problem will go away,” Rajan said on Tuesday delivering a lecture at Dr. Verghese Kurien Memorial Lecture in Gujarat. Banks.

Companies typically seek regulatory forbearance ahead of major loan recasts so that they don’t need to treat the loan as a bad and make high provisions against such assets.

It's quite a rarity that any central banker speaks this tough and in these many words against parties who seek regulatory forbearance from RBI. Especially given that many of these debtors come with the blessings of politicians, and saying that the RBI needs to be ‘realistic’ of the situation and postpone their problem.

“It is not realism but naiveté, for the lesson from across the world is that the problems only get worse as one buries one’s head in the sand,” said the former international monetary fund economist, who since he took over as governor of RBI, has acted as an agent of change for the financial system.

The not-so-covert message is aimed at those politicians who seek loan waivers to the tune of thousands of crores and industrialists who frequently knock the doors of RBI seeking permission to recast their bad loans still keeping them as standard.

Rajan’s harsh talk is understandable. There has been tremendous political pressure on the RBI in the recent years to allow the postponing of problems of troubled companies. The latest one among these was the demand for loan recasts worth tens of thousands of crores worth planned by southern states of Andhra Pradesh and Telangana. The RBI, under Rajan, has so far resisted the demand for such populist schemes.

Not just farmers, even industries facing financial difficulties for reasons that aren’t necessarily genuine, seek the RBI’s special dispensation to get temporary relief. In the past, this has happened with several industries such as microfinance, airlines and real estate firms.

But as Rajan pointed out regulatory forbearances must end for the following reasons:

One, as Rajan highlights, offering regulatory considerations only help to postpone the problem of today a bit, for some months at most. In most cases, the rot within indebted firms returns in the form of new restructuring proposals, even if assistance is given once.

A closer look at the cases where regulatory dispensation was offered the stress situation hasn’t improved enough to take care of the repayments. The relief offered is often short-lived, while the problems aren’t. Several indebted industries have now taken the cue and are seeking regulatory forbearances.

Firms which are facing genuine difficulties must be given assistance. But banks must exercise extreme caution while deciding such cases.

Two, hidden bad loans in the financial system are a bigger threat than declared bad loans. That’s because the regulator, bank and investor do not have a clear sense about how bad the situation is. Already a significant chunk of the stressed assets in India’s banking system is in the form of restructured loans—done through both the bilateral channel and corporate debt restructuring.

Based on conservative estimates, about Rs 6 lakh crore loans are being recast, as compared to the Rs 2.7 lakh crore declared gross non-performing assets in the banking system. A majority of the stressed asset cases have emerged from the balance sheets of Indian state-run banks, which accounts for 70 percent of the assets of the banking system. Whenever bank money is mismanaged, it is actually the taxpayers’ money that is at risk.

Three, to keep their balance sheets clean banks have resorted to massive loan recasts in many cases, even in those which didn’t warrant such action and in which repayments are technically absent. This is often done with the blessings of the politician-corporate-banker nexus. To resolve the bad loan situation, it is extremely important to break this nexus.

There is a huge chunk of bad money on the balance sheets of banks in the form of rejigged loans, which are no better than the ticking time bombs of bad loans.

"An NPA (non-performing asset) by any other name smells as bad! Indeed, because forbearance makes bank balance sheets opaque, they may smell worse to analysts and investors," Rajan said.

“So regulatory forbearance, which is a euphemism for regulators collaborating with banks to hide problems and push them into the future, is a bad idea,” he said.

The governor has rightly noted that the fundamental lesson of every situation of banking stress in recent years across the world is to recognize and flag the problem loans quickly and deal with them. By taking the courageous step to say no to regulatory forbearance, Rajan has begun the much needed cleanup process. The problem with a cancer such as this is that the more you delay acknowledging it, the faster you walk towards the dead end from where there is no return.